Valuation of New Goods Under Perfect and Imperfect Competition.

NBER Working Paper No. 4969 December 1994 JEL Nos. E52, E32, E44 Monetary Economics

The Consumer Price Index (CPI) attempts to answer the question of how much more (or less) income a consumer requires to be as well off in period one as in period zero, given changes in prices, changes in the quality of goods, and the introduction of new goods (or the disappearance of existing goods). However, the CPI has not attempted to estimate the effect of the introduction of new goods, despite the recognition of their potential importance in a cost-of-living index.

In this paper, I first explain the theory of cost-of-living indexes and then demonstrate how new goods should be included. The correct price to use for a good in its pre-introduction period is the "virtual price," which assumes that demand is zero. Estimating this virtual price requires estimation of a demand function, which in turn provides the expenditure function, which allows exact calculation of the cost-of-living index. The data requirements are extensive, and the need to specify and estimate a demand function...